Companies' ESG performance under soft and hard regulation environment

Can regulation narrow the gap between conflicting ESG ratings?

Bence Lukács and Péter Molnár study how regulatory regimes shape ESG rating divergence in their paper "Companies' ESG performance under soft and hard regulation environment".

They compare ESG ratings from Sustainalytics, S&P Global, and Refinitiv for the top 50 listed companies in the USA, China, Japan, Germany, and India. They classify each market by reporting and rating regulation and apply cluster analysis.

Their main conclusions include:

• Mean absolute divergence ranges from 48 in Japan to 82 in China, with the United States second highest at 72, showing voluntary disclosure regimes tend to widen gaps between raters.
• Cluster analysis groups Japan and India in a low-divergence cluster, while the United States, China, and Germany cluster together with high divergence.
• Germany clusters with unregulated markets in the divergence dendrogram because mandatory CSRD disclosure is not matched by direct oversight of rating agencies at the time of the study.
• Japan's soft-law Code of Conduct for ESG Evaluation and Data Providers delivers the lowest divergence among the five economies, which suggests targeted oversight of rating methodologies matters more than the legal form of the rule.
• India's BRSR mandate, applied progressively to the country's top 150, 250, and 500 listed firms is associated with rating consistency comparable to Japan, despite different institutional starting points.
• S&P Global scores show higher standard deviations than Sustainalytics or Refinitiv across all five countries, with country-level dispersion reaching 18 points in India.

This study shows hard reporting regulation is not enough on its own to improve signal quality for investors: enforcement of rating agency oversight matters as well, more so than the regulations' legal form.

Frameworks like CSRD and BRSR raise the reporting standards, but ratings remain inconsistent until methodologies, weighting schemes, and committee discretion are regulated as well on top of corporate disclosure mandates.

The study focuses on the 50 largest firms per country, which is a sample weighted toward issuers with mature ESG reporting capabilities, and the cross-sectional design overlooks the effects of regulatory transitions.